By Jane Young, CFP, EA
Inheriting money comes with a lot of emotions and mixed feelings. During this sad and disruptive period, take some extra time to plan and make logical decisions regarding your inheritance.
Fortunately, federal estate tax at a whopping 40%, only impacts extremely large estates. In 2022 federal estate tax will only apply to estates in excess of $12.06 million. This exemption is portable, providing couples who take the necessary steps a total exemption of $24.12 million. In addition to federal estate tax, about twelve states plus the District of Columbia levy their own estate tax. There is no estate tax in Colorado.
In addition to estate taxes, six states have an inheritance tax based on the relationship between the beneficiary and decedent and the value of the estate. There is no inheritance in Colorado or at the federal level. Fortunately, in most states, spouses, children, and parents, of the deceased are exempt from inheritance tax. State imposed estate tax and inheritance tax are based on where the decedent lived not where the heirs reside. Estate tax is levied on the estate and inheritance tax is levied on the heirs.
Most residents of Colorado will escape the burden of estate and inheritance tax, but you need to be aware of income and capital gains tax considerations on inherited money.
Rules on the distribution and taxation of retirement accounts is complex. Heirs typically move inherited retirement assets from an account in the decedents name to an inherited IRA. Spouses of the decedent can open an IRA in their own name and treat it as though it was their own IRA to begin with. If you take a distribution from an inherited retirement plan, you will owe regular income taxes on the amount distributed. This could result in a substantial tax bill and could push you into a higher tax bracket.
Retirement assets inherited from someone who died on or after January 1, 2020, are subject to the SECURE Act Rules. This act eliminated the “stretch” provision to take distributions over your lifetime. Under the SECURE Act, with a few exceptions including surviving spouses, you must exhaust the account within ten years. You will not be charged a 10% penalty if you are under 59 ½. The requirement to distribute your IRA within 10 years also applies to Roth IRAs but you will not owe any taxes.
The IRS has recently proposed a requirement to take required minimum distributions over the 10-year period. This has not been formally added to tax regulations, but the IRS is expected to provide guidance by the end of 2022.Non-retirement assets including bank accounts, real estate, and investments, receive a step-up in basis to the value on the decedent’s death. You will not owe any capital gains tax if you sell immediately. However, you will owe taxes on capital gains, dividends, and interest earned between the date of the decedent’s death and when you sell the asset.